As technology evolves, the US Securities and Exchange Commission (SEC) must evolve with it. Nothing is more true than crypto, and today: The market for crypto assets has grown in size and sophistication so much so that the SEC’s recent disastrous approach to enforcement and deregulation requires an urgent update.
While the long-term future of the crypto industry in the US will likely require Congress to sign a comprehensive regulatory framework into law, here are 6 steps the SEC can take immediately to create “appropriate” regulations for the purpose” – without sacrificing innovation or critical investor protection.
#1 Provide guidance on ‘airdrops’
The SEC should provide interpretive guidance for how blockchain projects can distribute incentive-based crypto rewards to participants — without characterizing them as security offerings.
Blockchain projects usually offer such rewards – often called “airdrops” – to incentivize the use of a particular network. These distributions are a critical tool for enabling blockchain projects progressively decentralizedas they distribute ownership and control of a project to its users.
If the SEC were to issue guidance on distributions, it would prevent rewards being awarded only to non-US residents — a trend that effectively alienates ownership of US-developed blockchain technologies, but at the expense of investors. of US and developers.
What to do:
Establish eligibility criteria for crypto assets that may be excluded from treatment as investment contracts under securities laws when distributed as airdrops or incentive-based rewards. (For example, crypto assets that are not securities and whose market value is, or is expected to be, substantially derived from the programmatic functioning of any distributed ledger or onchain executable software.)
#2 Change the crowdfunding rules
Must be revised by the SEC Regulation Crowdfunding rules so that they are suitable for crypto startups. These startups often need a wider distribution of crypto assets to build critical mass and network effects for their platforms, applications, or protocols.
What to do:
Expand the offering limits so that the maximum amount that can be raised is equal to the needs of crypto ventures (eg, up to $75 million or a percentage of the overall network, depending on the depth of disclosures).
Exempt crypto offerings in a manner similar to Regulation Dwhich allows access to crowdfunding platforms beyond accredited investors.
Protect investors through limits on the amounts any individual can invest (as Reg A+ currently does); robust disclosure requirements covering material information related to the crypto venture (e.g. related to the underlying blockchain, its governance, and consensus mechanisms); and other safeguards.
These changes will empower early-stage crypto projects to access a broad pool of investors, democratizing access to opportunities while maintaining transparency.
#3 Enable broker-dealers to operate in crypto
The current regulatory environment restricts traditional broker-dealers from meaningful involvement in the crypto industry — primarily because it requires brokers to obtain separate approvals to transact in crypto assets, and imposes of heavier regulation around broker-dealers who want to custody crypto assets.
These restrictions create unnecessary barriers to market participation and liquidity. Removing them would improve market functioning, investor access, and investor protection.
What to do:
Enable registration so that broker-dealers can deal in – and custody – crypto assets, both securities and nonsecurities.
Establish oversight mechanisms to ensure compliance with anti-money laundering (AML) and know-your-customer (KYC) regulations.
Work with industry authorities such as FINRA to issue joint guidance addressing operational risks tailored to crypto assets.
This approach will promote a safer and more efficient marketplace, allowing broker-dealers to bring their expertise in best execution, compliance, and safeguards to the broader crypto market.
#4 Provide maintenance and repair guidance
Ambiguity in regulatory treatment and accounting rules has prevented traditional financial institutions from entering the crypto custody market. This means that many investors do not get the benefit of fiduciary asset management for their investments, and are instead left investing on their own and arranging their own custodial alternatives.
What to do:
Clarify guidance on how investment advisors can hold crypto assets under Investment Advisers Actensuring adequate safeguards such as multi-signature wallets and secure offchain storage. Also provide guidance on staking and voting on management decisions for crypto assets in the custody of investment advisors.
Develop specific settlement guidance for crypto transactions – including timelines, validation processes, and error resolution mechanisms.
Establish a flexible, technology-neutral framework that can adapt to care solution innovations, meeting regulatory standards without imposing prescriptive technological mandates.
Straighten accounting treatment by repealing the SEC Staff Accounting Bulletin 121 and its handling of balance sheet liabilities for custodial crypto assets. (SAB 121 transfers custodial crypto assets to the custodian’s balance sheet — a practice contrary to the traditional accounting treatment of custodial assets.)
This clarity will provide greater institutional confidence, increasing market stability and competition among service providers while improving protections for both retail and institutional crypto investors.
#5 Reform the ETP standards
The SEC should adopt reform measures for products traded on the exchange (ETPs) that can promote financial innovation. The proposals promote greater market access to investors and fiduciaries used to manage portfolios of ETPs.
What to do:
Return to the historical market size test, which requires only sufficient liquidity and price integrity for the regulated commodity futures market to exist to support a spot ETP product. Currently, the SEC’s reliance on “Winklevoss test” for monitoring agreements in regulated markets that meet arbitrary predictive price discovery has delayed the approval of bitcoin and other crypto-based ETPs. This approach overlooks the significant size and transparency of current crypto markets, their regulated futures markets, and creates an arbitrary distinction in the standards applicable to crypto-based ETP listing applications and all other commodity-based listing applications.
Allow crypto ETPs to live directly on the underlying asset. This will result in better fund monitoring, reduce costs, provide greater price transparency, and reduce reliance on riskier derivatives.
Mandate strong security standards for physically settled transactions to reduce the risks of theft or loss. Additionally, provide the option of staking the idle underlying assets of the ETP.
#6 Implement certification for ATS listings
In a decentralized environment where the issuer of a crypto asset may not have a significant ongoing role, who is responsible for providing accurate disclosures around the asset? There is a useful analog from traditional security markets here, in the form of Exchange Act Rule 15c2-11which allows broker-dealers to trade a security when current information for the security is available to investors.
Extending that principle to crypto asset markets, the SEC may allow regulated crypto trading platforms (both exchanges and brokerages) to trade any asset where the platform can provide investors with accurate, current information . The result will be greater liquidity for such assets in SEC-regulated markets, while simultaneously ensuring that investors are prepared to make informed decisions.
What to do:
Establish a streamlined 15c2-11 certification process for crypto assets listed on alternative trading system (ATS) platforms, providing mandatory disclosures about the design, purpose, functionality, and risks of assets.
Require exchanges or ATS operators to perform due diligence on crypto assets, including verifying the identity of the issuer as well as key feature and functionality information.
Mandate periodic disclosures to ensure that investors receive timely and accurate information. Also, clarify whether an issuer’s reporting is no longer required due to decentralization.
This framework will promote transparency and market integrity while allowing innovation to flourish.
***
By taking the above steps now, the SEC can begin to pivot from its historic and hotly contested focus on enforcement efforts, and instead add much-needed regulatory guidance. Providing practical solutions for investors, fiduciaries, and financial intermediaries will better balance protecting investors with fostering capital formation and innovation — achieving the SEC’s mission.
A longer version of this post originally appeared on a16zcrypto.com.
